In investing and in life, panicking is rarely an effective response to obstacles. But investors with a long-term mindset might be getting a little nervous with Renewable Energy Group (REGI).
The nation's largest biodiesel producer recently announced that a long-awaited joint venture with Phillips 66 (PSX 0.63%) will no longer be completed. The joint venture had teased plans to build a 250-million-gallon-per-year (mmgy) renewable diesel facility on the West Coast. It would have given Renewable Energy Group easy access to markets that follow a lucrative subsidy program initiated by California, represented the highest-margin production facility in the company's fleet, and more than tripled the volume of renewable diesel produced from the company's technology platform.
Now, investors are left with more questions than answers for the renewable energy stock. Most important: What happens next?
How did we get here?
At the end of last year, Congress decided to retroactively reinstate the federal biodiesel excise tax credit (BTC) that had expired on the last day of 2017 and extend it through 2022. The BTC provides a $1-per-gallon subsidy that generally goes to the producer of biomass-based diesel. It's quite the development.
The retroactive reinstatement of the BTC will create a windfall of more than $500 million for Renewable Energy Group from production in 2018 and 2019. The amount likely will be accounted for as nearly cost-free revenue in the first quarter of 2020. Meanwhile, the extension of the BTC could create a subsidy revenue stream of $1 billion in total for production in the next three years.
The congressional rescue of the BTC appeared to clear the path for Renewable Energy Group to invest in its future: renewable diesel.
Both biodiesel and renewable diesel are biomass-based fuels, but renewable diesel is chemically similar to petroleum-based diesel. That means it can be blended seamlessly with petrol, consumed in all climates, and sold for a premium to biodiesel. Due to the manufacturing process, renewable diesel can also be produced in much larger facilities, which extends economic advantages over biodiesel. In other words, it sells for more and can be produced for less -- exactly the product the money-losing business needs to focus on.
In fact, Renewable Energy Group's lone renewable diesel manufacturing facility generated over half of the company's total adjusted EBITDA in 2018, despite representing only 20% (or 90 mmgy) of total production capacity.
Therefore, with a windfall on the way from the reinstated BTC and certainty on the horizon from the extended BTC, investors were counting the days until Renewable Energy Group and Phillips 66 announced an investment decision on a 250 mmgy renewable diesel facility.
It would have been the largest on the West Coast. It was to be located at the partner's Ferndale, Washington, refinery -- providing access to existing utilities, infrastructure, and petroleum-based diesel for blending. And considering the California Low Carbon Fuel Standard (LCFS) program -- followed by other western states and Canadian provinces -- provides a generous state subsidy for renewable diesel in addition to the BTC, the planned facility was poised to become a significant earnings generator.
But the plan will not materialize. Phillips 66 walked away after stating that "permitting uncertainties were leading to delays and higher costs." It's not unusual for large, complex engineering projects to succumb to obstacles, but the overwhelming significance of the project to Renewable Energy Group makes the cancellation all the more painful. What can the company do to limit the blow?
Limited options, but expect a similar playbook
Renewable Energy Group has a few things going for it. The business will receive a more-than-$500 million windfall soon and can operate with the certainty provided by the extended BTC. The business will likely start by paying off its $115 million in existing term debt (not the kind of debt for a low-margin, commodity-driven business to carry).
The renewable fuels leader has also previously disclosed it intends to invest in a large-scale expansion of its existing renewable diesel facility in Geismar, Louisiana. The asset doesn't enjoy the same geographic advantages as the mothballed Ferndale project, but at an effective capacity of about 90 mmgy, the facility likely could be doubled in size.
Renewable Energy Group also wields the proprietary BioSynfining technology for producing renewable diesel from biomass. If that was once valuable to Phillips 66, then it will likely help to attract other petroleum refiners with deep pockets. There are no publicly known discussions under way, and project planning would have to start from scratch, but investors might expect Renewable Energy Group to shop around for other partners interested in building a new, large-scale project.
Don't panic, but do pay close attention
The key thing for investors to remember is that the end of 2022 -- and the end of the BTC -- is closer than it seems. Renewable Energy Group reported an operating loss of $104 million in the first nine months of 2019. While that was driven by a combination of factors, not all sustainable, it highlights the urgency of the situation.
Simply put, the business must invest heavily in renewable diesel to lessen its dependence on government subsidies, but it must do so while protecting its balance sheet (and hopefully not blowing money on share buybacks) and not underselling its technology platform.
This is the first real test for recently appointed CEO Cynthia Warner and she'll need to present a coherent roadmap on the upcoming fourth-quarter 2019 earnings conference call. For now, I'm still inclined to think investors should give the company the benefit of the doubt, but don't lose sight of the importance of hitting the ground running in 2020.